R. Christopher Whalen
Jan 306 min
January 30, 2024 | Premium Service | In response to reader requests, we look at three banks – Bank of America (BAC), American Express (AXP) and SoFi Technologies (SOFI). We’ll start with the smallest, $27 billion asset SOFI, and work our way up the proverbial value chain in terms of asset size.
SOFI Technologies
SOFI has been a bank holding company since 2022 and is primarily engaged in consumer finance. The GAAP disclosure contained in the Form Y9 is not particularly flattering for the $27 billion asset bank. SOFI’s GAAP earnings report and presentation looks more akin to a technology company than a bank.
We find the mixture of GAAP and adjusted results on the same page confusing. For retail investors, the SOFI disclosure is opaque. Fortunately we have the standardized performance metrics from the Federal Reserve. The chart below shows the five-year chart for SOFI, BAC and AXP. Notice how the correlation between AXP and BAC has weakened in the past two years.
Source: Google Finance (1/30/24)
Contrast the GAAP presentation of SOFI from the FFIEC vs the “adjusted” reality presented by SOFI management. SOFI is confined to the Peer Group 9 ghetto in terms of industry comparables, a very odd choice given the bank's consumer focus. SOFI ought to be part of Peer Group 1.
SOFI reported losses equal to 2% of average assets in Q3 2023. Banks in Peer Group 1 reported return on assets of 1.1% last quarter. Not surprising, SOFI has significantly underperformed the rest of the fintech group. No longer a fintech darling, SOFI is more and more just a bank competing with the likes of Ally Financial (ALLY).
The continuing problem for SOFI is size, with overhead expenses over 10% of assets vs say 4% for CapitalOne Financial (COF) and 2.5% for the average of Peer Group 1, which as a simple average reflects the smaller banks among the 133 in the group. Average personnel expense for SOFI is just short of $150,000 vs $122,000 for COF and only double-digits for Peer Group 1. Key performance metrics like assets per employee are well-below industry levels.
Essentially SOFI needs to at least double in size to grow into that pricey personnel overhead, but we are not sure that the overhead will fall given topline growth. The lack of scale is illustrated by the 120% efficiency ratio. Naturally SOFI places a lot of its emphasis on growing customers and upselling a variety of products to these customers. But what is the lifetime value of a SOFI customer?
The investment revenues reported in Q4 2023 are too small to be significant to the business. The only way to make the SOFI strategy work is scale, thus the emphasis on sheer growth in the firm’s verbose disclosure. But if the bank’s expenses need to grow less than revenue, SOFI needs to start reducing costs on line with its bank competitors.
The vast majority of SOFI's revenue comes from loan production. Three quarters of SOFI’s production in 2023 came from $13.8 billion of new personal loans, with student loans ($2.6 billion) and 1-4 family mortgages ($900 million) making up the remaining 25%. From the adjusted SOFI perspective, the firm made $2.1 billion in net revenue and $431 million in “adjusted EBITDA” in 2023.
SOFI’s cost of funds is ~5% vs just under 3% of average assets for COF. SOFI’s gross spread near 10% and NIM over 6% net of funding costs is definitely in the right neighborhood. Good news: SOFI does not offer commercial loans.
Frankly, we’d compare SOFI to CapitalOne, but the San Francisco-based bank needs to get bigger first. SOFI is lagging behind most of our fintech group, but would rank #2 with UBS AG (UBS) in our bank group. SOFI still wants to be thought of as a fintech stock, but it is really becoming a pretty plain vanilla consumer bank with relatively high expenses and funding costs. We’re moving SOFI to the bank list.
American Express
When we look at American Express (AXP), we are talking about one of the best performers in the financial industry. Names like COF and ALLY passed AXP in the Fed pivot updraft in December, but none of these stocks is trading over 5x book value.
AXP saw $350 billion in billed volumes in Q4 2023 and $1.5 trillion for the full year. Volumes were up 9% for the year and net revenue up 15%, yet some on the Street were disappointed. Guidance for 2024 projects double digit volume and net revenue growth. The big questions are the economy and the consumer, but so far both of these factors seem positive.
AXP loan loss provisions were up 40% in Q4 2023, confirming our observations of a credit build at other banks with significant consumer exposures. Consolidated provisions for credit losses for the full year were $4.9 billion, compared with $2.2 billion a year ago.
The AXP provision increase reflected higher net write-offs and a net reserve build of $1.4 billion, compared with a reserve build of $617 million a year ago. The industry is preparing for higher or at least normal loss rates, yet AXP credit provisions are still barely back to Q1 2020 levels. The table below shows pretax, pre-provision income for AXP. Now you see why AXP trades for 5x book, even with weakness among other bank names.
Source: AXP (1/30/2024)
COF and ALLY are fading with growing worries of an eventual recession, but as with SOFI, at least AXP does not make or hold commercial mortgage loans. The strong income generated by the AXP business lines gives the company more than enough firepower to deal with elevated credit costs. The market will punish AXP if credit provisions continue to rise, but in the event investors then will have an opportunity and a decision. AXP is a premium stock that is best acquired when people think, incorrectly, that the world is ending.
Bank of America
If SOFI is the bad and AXP is the good, borrowing a metaphor from the Clint Eastwood spaghetti Western film directed by Sergio Leone, Bank of America is the ugly bank. The yield on earning assets for this $3.1 trillion asset behemoth is just above 5%. The bank’s interest bearing liabilities cost 4%. Net interest spread is 1.1%. See page nine of the Q4 2023 earnings supplement. Add in non-interest sources of income and we get up to 1.97% net interest income.
Source: BAC (1/30/23)
BAC has reduced their negative balance of other comprehensive income by moving billions of dollars worth of loans and securities from “available for sale” to ‘held to maturity.” The recharacterization of assets, however, does not solve the problem of yield illustrated in the previous paragraph.
Even though BAC managed to double its gross interest income in 2023, net interest income barely moved as funding costs more than kept pace. But frankly, the entire industry has the same problem. The difference with BAC is that a large chunk of the bank’s assets are underwater given a 4% cost of funds. Neither AXP nor SOFI have this problem, of note.
Source: FFIEC
Perhaps the most striking comparison is between JPMorgan (JPM) and BAC. At $3.8 trillion in total assets, JPM is 20% larger than BAC, but that does not explain the difference in financial performance. JPM generates significantly higher asset returns than BAC and does a far better job of managing the overall duration of the balance sheet, which contributes to asset returns.
Source: BAC, JPM Q4 2023
BAC earnings were down YOY and sequentially in Q4 2023. Net interest income fell from $14.6 billion in Q4 2022 to $13.9 billion in Q4 2023. Our concern for the future is that BAC and a number of other banks may find themselves being squeezed even further. Note that the narrative of an interest rate cut in March or even June is being walked back by the Street.
The good news is that BAC's credit provisions were up modestly in 2023. Bad news is that higher credit expenses in the future could consume much of the bank's meager income and force BAC into realizing losses due to asset sales. Consumer defaults at BAC remain very quiet, but commercial NPLs have more than doubled over the past year, albeit from a very low base. If we see credit expenses rising as rapidly during 2024, then the stock is likely to come under renewed pressure.
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